The mortgage crisis of 2008

Mortgage lending is likely to dry up next year. That's the stark warning from the industry. So what exactly will it mean for borrowers and who will be worst affected? This is Money Editor Andrew Oxlade sets out what he expects in the mortgage crisis of 2008...

Bad news has not exactly been in short supply in recent months with the subprime crisis and the credit crunch it caused continuing to impact on British banks, most notably Northern Rock.

But today British borrowers, who have been watching the fallout of the global credit crisis with a mix of fear and bemusement so far, have been given warning of the looming 'perfect storm' that will affect their lives and finances more directly in 2008.

The International Monetary Fund yesterday warned surging oil prices and the turbulence on financial markets caused by the credit crunch might bring a 'big reduction in international trade from which no one would be immune'. Grim stuff.

It then got worse with the UK's Council of Mortgage Lenders warning of a lack of money available to fund mortgage markets 'if capital markets do not open next year'.

And then today, the UK's largest building society warned house prices fell in November at their fastest pace in 12 years.

Could it get worse? Yes. The Bank of England then warned of a slump in new mortgages - from 102,000 in September to 88,000 in October - and its governor Mervyn King told MPs on the Treasury select committee that getting a mortgage could become more difficult: 'I'm sure lenders will feel more constrained in their ability to fund mortgage lending.'

The consumer has witnessed some pretty gloomy warnings in recent months, but nothing so clearly defined and repeated in so many quarters as it has been this week. Quite simply, mortgage costs are set to soar for all.

Because of the credit crisis, banks are simply not lending to each other as none know exactly how badly the others are exposed to subprime borrowing in the US.

So unless UK mortgage lenders can raise money from British savers - unlikely given the historic low rate of savings - there simply won't be so much money to lend in the form of mortgages.

The result? Mortgages will be more expensive. The special deals - the two year 'discounts', the three-year 'fixed rates' - that borrowers have come to take for granted may be withdrawn and even standard variable rates could surge higher regardless of what the Bank of England does with its official borrowing rate (expectations are currently for a cut in February).

Those people who see their introductory mortgage deals end next year and who were hoping to switch may suddenly find it difficult to find a cheaper deal.

The people most at risk are those who have bought a home in the past year or two with only a 5% or 10% deposit.

Lenders are likely to tighten criteria further and increasingly refuse the cheapest deals to borrowers with a loan-to-value of 95% or more. And if that person's house price falls 5%, they would only be eligible for an even more expensive 100% mortgage.

But the scenario for some buy-to-let investors is worse. People who have bought 'off-plan' may find that by the time they come to secure a mortgage for the completed property that lenders, already feeling the credit squeeze, refuse to give a mortgage on a property that is valued at less than the loan required. The investor faces losing the deposit or raising money elsewhere, such as via equity in their own home - a risky strategy.

The impact of all this on the property market is anyone's guess. Property demand continues to rise in the UK thanks to demographics and immigration and supply is contained by planning restraints, but basic economic theory suggests that by turning off the taps in the form of reduced demand, with less mortgage money on offer, will put the market - and British borrowers - under pressure.